After years of mostly strong investment markets, spurred on by excessively easy money and ultra-low interest rates, markets around the world and all asset classes deflated last year as central banks reversed course and started tightening. U.S. stocks, world stocks, bonds, both long and short term, crypto, real estate: everything fell in a volatile year, most down by double digits.
There Were Few Places To Hide
Looking back, international stocks (per the MSCI World ex-U.S.) were down over 18%, falling slightly less than U.S. stocks, with the S&P down over 19% for the year (with the Dow less, Nasdaq more, 32%). Only Singapore and Brazil, among major world markets, ended the year with positive returns. Global funds (per the Bloomberg Global Equity Index) fell almost 21% for the year.
Commodities, as always, were mixed. The biggest winners were in the energy complex, with WTI up nearly 7%. Coal was up almost 40%, and most of the agricultural were also up for the year. Among the metals, other than nickel (up 45%), most were down. Gold closed the year essentially flat, while silver was up a little less than 3%, a strong performance in the face of rate hikes and a strong dollar, two headwinds for the precious metals. Precious metals funds fell over 10% on average for the year.
We Had Some Winners
So it was not an easy year. We had some strong winners among the stocks on our list, particularly, I am happy to say, among those I was consistently and repeatedly recommending buying. Leading the pack were two of my favorites, Altius Minerals Corp. (ALS:TSX.V) and Lara Exploration Ltd. (LRA:TSX.V), up 25% and 29%, respectively. Others, including another top recommendation Orogen Royalties Inc. (OGN:TSX.V), were up in the mid-teens, while several ended more-or-less flat.
Needless to say, however, many stocks, both resource, and global equities, fell with the markets, though some are now at very good buying levels. The main cause of assets of all types around the world collapsing was the tightening policies pursued by the world’s central banks, most importantly the Federal Reserve.
After the Fed’s last meeting of the year, chairman Jerome Powell said that conditions were still not “sufficiently restrictive,” while Fed members, in their so-called “dot-plot” predicting future economic conditions, raised their expectations for the level of interest rates next year and beyond.
However, despite a hawkish message, there are signs of a softening after an unprecedented pace of rate hikes. Significantly, in its annual rotation of voting members, the rate-setting Open Market Committee is losing three supposed “hawks,” including James Bullard from the St. Louis Fed, and gaining several doves.
Powell, as chairman, has the authority to overrule any committee vote, a more dovish committee, more focused on the condition of the economy, can certainly add pressure to pause.
What’s the Truth of Employment?
Powell is also changing his tune on the possibility of a recession, now saying only that he still sees “a path to a soft, or soft-ish landing.” Powell, and others at the Fed, are placing much of their faith in economic health on the apparent strength of the labor market, but that is not as strong as they seem to believe.
There has been a wide and growing difference between the two government labor market reports, with the household survey painting a far weaker picture than the payroll report, which Powell likes to refer to. The gap is now approaching 3 million workers, so it is not insignificant. If the payroll report follows the household survey down, then that removes support for Powell’s contention that the economy remains strong.
Other sectors of the economy are demonstrating signs of weakness, despite a positive GDP number in Q3. Changes in interest rates have long, and variable lags before their impact on the economy is evident.
Housing and autos, which are two interest rate-sensitive areas of the economy, feel the changes first, but other areas can take a year or more. So we have not yet seen the impact of the tightening already done. We could continue looking at sector after sector, and signs of current weakness abound.
A Recession Is All-But Certain
Looking ahead, however, things get more certain. Arguably the most reliable indicator of future recession is the Conference Board Leading Economic Index, which is down about 4% on the year. A recession has always followed such a decline in the LEI.
The last decline of this magnitude was in December 2007.
It seems very clear that beneath the headline numbers, this economy is in trouble, with reliable indicators of future recession clearly pointing in that direction. We suspect that by the middle of this coming year, it will be clear that the economy is in a recession.
Other Global Banks Tightening, but Not China
Other major central banks may be late to the party but have been trying to catch up with the Fed. Even the Bank of Japan, which has been suppressing yields for years, just last week indicated that its policy is finally changing, as it widened the target range for yields.
The BoJ move is important in policy terms and will have an impact on markets around the world. It will be negative for global bond markets, positive for the yen and negative for the dollar, and potentially positive for the long-moribund Japanese stock market.
The other recent significant development also came from the East, with China backing away from its zero-covid policy and opening the economy. This is positive for regional markets and currencies, as well as for commodities, as one can expect Chinese imports to recover.
Contrary to other central banks, the People's Bank of China has said there will be increased government spending to “provide more forceful support for the economy” and expand domestic demand.
We are holding our Singapore stocks — Hutchison Port and Kingsmen Creatives — both of which should benefit from China re-opening.
The Bear Market in Equities Is Not Over
There is some optimism in certain quarters that the bear market is over. But the truth is that bear markets take time to play out as more and more bulls give up. Were the bear market already over, it would have been only half as deep and half as long as most previous bear markets.
It is important to emphasize that though a clear pause or pivot would see a rally, it would not necessarily mark the beginning of a new bull market. If we look at previous occasions when rates stopped going up, half of them saw losses of more than 20% after the final hike.
On most historical occasions, the market declined more after rates stopped going up than before.
This does not mean there will not be rallies. Sometimes strong rallies. But will be against a background of eroding prices. On balance, we must expect further declines in the coming year, while the value will continue to hold up better than growth, overseas markets better than the U.S., and smaller markets better than developed. Our global stocks are positioned for such a trend.
Resources Will Be Stand-Outs This Year
China's re-opening will boost demand for resources, but we are emphasizing resources driven by the shortage of supply as much as expected increases in demand.
Right now, this means copper and oil and gas. Although we currently have no pure copper or oil companies on our list, we have exposure to both through other companies: Barrick Gold Corp. (ABX:TSX; GOLD:NYSE) and Altius both have significant copper revenues, while several of our exploration companies, including Midland Exploration Inc. (MD:TSX.V) and Orogen, has meaningful copper programs; and Franco-Nevada obtains about 20% of its revenues from oil and gas.
Gold Is Turning as Investors Look for Safety
Pan American Silver Corp. (PAAS:TSX; PAAS:NASDAQ), Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE), and Wheaton Precious Metals Corp. (WPM:TSX; WPM:NYSE),
The largest exposure on our list, however, is for gold. Like Rodney Dangerfield, gold got no respect in 2022, but it ended the year more-or-less flat (down less than 0.3%), an impressive performance in the face of higher interest rates (Fed Funds rate from 0.25% to 4.5%) and a stronger dollar (up 7.6%), two powerful headwinds for gold. This is particularly impressive in the context of other assets that collapsed during the year.
As we wrote in our Bulletin 844, two things helped gold: increased central bank buying and investors slowly turning to gold as belief in the Fed’s narrative began to fade.
As we wrote, gold would move when more investors began to realize that the Fed and other central banks would not be able to defeat inflation without causing a serious recession. If the economy goes into a recession before inflation is tamed, gold will respond; and the dollar will drop if investors think the Fed will pause even as other central banks are ramping up their inflation-fighting rate hikes.
Gold Stocks Remain Undervalued Amidst Positive Outlook
Again, despite a 32% jump in the senior gold stocks since the September lows, the stocks are selling well below their historical valuations, while, of course, cash flows and asset values increase with the price of gold.
The recent move well demonstrates the leverage that gold stocks have to bullion, with the stocks moving almost three times as much as bullion. But, as we discussed, the stocks still have a lot of catching up to do to return to their historical ratio to bullion.
Silver was, as always, more volatile than gold, falling further in the middle of the year.
But since the turn in September, silver has moved up two-and-a-half times as much as gold. This is typically a bullish sign for precious metals.
As we have discussed previously, most silver production is by-products from zinc or lead mines; the number of new mines with significant silver production is at its lowest in 20 years.Ares Capital Corp. (ARCC:NASDAQ) and Gladstone Investment Corp. )
This makes it difficult to estimate silver production in the years ahead, but we expect it to decline even as its demand for both specialized industrial uses as well as investment demand grows.
There are fewer silver producers than there are gold, and even many miners with “silver” in the name or viewed as silver miners actually produce far more gold than silver. This means, however, that when investors return to the sector, more money will be chasing fewer names. We own silver “silver” stocks, including Pan American Silver Corp. (PAAS:TSX; PAAS:NASDAQ), Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE), and Wheaton Precious Metals Corp. (WPM:TSX; WPM:NYSE), while Orogen’s current revenues are all from silver.
Overall, we are cautious on global markets but increasingly positive on gold and silver, as well as some of the other resources.
We will maintain our exposure to high-dividend payers in the U.S., such as Ares Capital Corp. (ARCC:NASDAQ) and Gladstone Investment Corp. (GAIN: NASDAQ), as well as to a small handful of global blue chips that are resistant to economic declines (notably Nestle).
We continue to hold a high exposure to gold and silver. In the coming months, we expect to trim our list of laggards (or, indeed, stocks that have achieved their targets), but the overall balance will likely remain much the same for the foreseeable future.
In other news, Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) may see a resolution to the dispute over its largest asset, First Quantum’s Cobre Panama mine.
The Panama government said today that it had presented a final contract to the company following the resumption of talks last week.
From Franco’s point of view, the mere continuation of operations by First Quantum is more important than the particular details of the agreement since it holds a stream on production, not on profits. We are holding Franco.
TOP BUYS this week are Nestle SA (NESN:VX; NSRGY:OTC) and Lara Exploration Ltd. (LRA:TSX.V).
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